Global Business Today, 5e - · PDF fileEntering Foreign Markets ... (acquisition strategy)? Entering Foreign Markets . ... Global Business Today, 5e Author: Hill

chapter

Entering Foreign Markets

9


INTRODUCTION

A firm expanding internationally must decide:

• which markets to enter

• when to enter them and on what scale

• how to enter them (the choice of entry mode)

There are several options including:

• exporting

• licensing or franchising to host country firms

• setting up a joint venture with a host country firm

• setting up a wholly owned subsidiary in the host country to serve that market


The advantages and disadvantages associated with each entry mode is determined by:

• transport costs and trade barriers

• political and economic risks

• firm strategy

While it may make sense for some firms to serve a market by exporting, other firms might set up a wholly owned subsidiary, or utilize some other entry mode.


BASIC ENTRY DECISIONS

There are three basic decisions that a firm contemplating foreign expansion must make:

• which markets to enter

• when to enter those markets

• on what scale


Which Foreign Markets? The choice between different foreign markets is based on an assessment of their long run profit potential. • Typically, the most favorable markets are those that are politically stable developed and developing nations that have free market systems, and where there is not a dramatic upsurge in either inflation rates, or private sector debt •Those that are less desirable are politically unstable developing nations that operate with a mixed or command economy, or developing nations where speculative financial bubbles have led to excess borrowing • Firms are more likely to be successful if they offer a product that has not been widely available in a market and that satisfies an unmet need


Timing of Entry

• With regard to the timing of entry, we say that entry is

early when an international business enters a foreign

market before other foreign firms, and late when it enters

after other international businesses have already

established themselves in the market


The advantages associated with entering a market early

are called first mover advantages, and include:

• the ability to pre-empt rivals and capture demand by

establishing a strong brand name

• the ability to build up sales volume in that country and ride

down the experience curve ahead of rivals and gain a cost

advantage over later entrants

• the ability to create switching costs that tie customers into

their products or services making it difficult for later entrants

to win business


Disadvantages associated with entering a foreign market

before other international businesses are referred to as

first mover disadvantages and include:

• Pioneering costs (costs that an early entrant has to bear

that a later entrant can avoid)


Scale of Entry and Strategic Commitments

• The consequences of entering a market on a significant scale are associated with the value of the resulting strategic commitments (decisions that have a long term impact and are difficult to reverse)

• Deciding to enter a foreign market on a significant scale is a major strategic commitment that changes the competitive playing field

• Small-scale entry has the advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firm’s exposure to that market


ENTRY MODES

These are six different ways to enter a foreign market.

Exporting

• Most manufacturing firms begin their global expansion as

exporters and only later switch to another mode for

servicing a foreign market


Advantages

• Exporting avoids the substantial cost of establishing

manufacturing operations in the host country

• Exporting may also help a firm achieve experience curve

and location economies


Disadvantages

• There may be lower-cost locations for manufacturing

abroad

• High transport costs can make exporting uneconomical

• Tariff barriers can make exporting uneconomical

• Agents in a foreign country may not act in exporter’s best

interest


Turnkey Projects

• In a turnkey project, the contractor agrees to handle

every detail of the project for a foreign client, including the

training of operating personnel

• At completion of the contract, the foreign client is handed

the "key" to a plant that is ready for full operation


Advantages

• Turnkey projects are a way of earning great economic

returns from the know-how required to assemble and run a

technologically complex process

•Turnkey projects make sense in a country where the

political and economic environment is such that a longer-

term investment might expose the firm to unacceptable

political and/or economic risk


Disadvantages

• By definition, the firm that enters into a turnkey deal will

have no long-term interest in the foreign country

• The firm that enters into a turnkey project may create a

competitor

• If the firm's process technology is a source of competitive

advantage, then selling this technology through a turnkey

project is also selling competitive advantage to potential

and/or actual competitors


Licensing

• A licensing agreement is an arrangement whereby a

licensor grants the rights to intangible property to another

entity (the licensee) for a specified time period, and in

return, the licensor receives a royalty fee from the licensee

• Intangible property includes patents, inventions, formulas,

processes, designs, copyrights, and trademarks


Advantages

• The firm does not have to bear the development costs and risks associated with opening a foreign market

• The firm avoids barriers to investment

• It allows a firm with intangible property that might have business applications, but which doesn’t want to develop those applications itself, to capitalize on market opportunities


Disadvantages

• The firm doesn’t have the tight control over

manufacturing, marketing, and strategy that is required for

realizing experience curve and location economies

• Licensing limits a firm’s ability to coordinate strategic

moves across countries by using profits earned in one

country to support competitive attacks in another

• There is the potential for loss of proprietary (or intangible)

technology or property

• One way of reducing this risk is through the use of cross-

licensing agreements where a firm might license

intangible property to a foreign partner, but requests that

the foreign partner license some of its valuable know-how

to the firm in addition to a royalty payment


Franchising

• Franchising is basically a specialized form of licensing in

which the franchisor not only sells intangible property to the

franchisee, but also insists that the franchisee agree to

abide by strict rules as to how it does business


Advantages

• The firm avoids many costs and risks of opening up a

foreign market


Disadvantages

• Franchising may inhibit the firm's ability to take profits out

of one country to support competitive attacks in another

• The geographic distance of the firm from its foreign

franchisees can make poor quality difficult for the franchisor

to detect


Joint Ventures

• A joint venture is the establishment of a firm that is jointly

owned by two or more otherwise independent firms


Advantages

• A firm can benefit from a local partner's knowledge of the

host country's competitive conditions, culture, language,

political systems, and business systems

• The costs and risks of opening a foreign market are

shared with the partner

• Political considerations may make joint ventures the only

feasible entry mode


Disadvantages

• A firm risks giving control of its technology to its partner

• The firm may not have the tight control over subsidiaries

that it might need to realize experience curve or location

economies

• Shared ownership can lead to conflicts and battles for

control if goals and objectives differ or change over time


Wholly Owned Subsidiaries

In a wholly owned subsidiary, the firm owns 100 percent of the stock.

Establishing a wholly owned subsidiary in a foreign market can be done two ways:

• the firm can set up a new operation in that country

• the firm can acquire an established firm


Advantages

• A wholly owned subsidiary reduces the risk of losing

control over core competencies

• A wholly owned subsidiary gives a firm the tight control

over operations in different countries that is necessary for

engaging in global strategic coordination (i.e., using profits

from one country to support competitive attacks in another)

• A wholly owned subsidiary maybe required if a firm is

trying to realize location and experience curve economies


Disadvantage

• Firms bear the full costs and risks of setting up overseas

operations


Technological Know-How

• A firm with a competitive advantage based on proprietary

technological know-how should avoid licensing and joint

venture arrangements in order to minimize the risk of losing

control over the technology

• If a firm believes its technological advantage is only

transitory, or the firm can establish its technology as the

dominant design in the industry, then licensing may be

appropriate even if it does involve the loss of know-how


Management Know-How

• The competitive advantage of many service firms is based

upon management know-how

• The risk of losing control over the management skills to

franchisees or joint venture partners is not high, and the

benefits from getting greater use of brand names is

significant


Pressures for Cost Reductions and Entry Mode

• The greater the pressures for cost reductions, the more

likely a firm will want to pursue some combination of

exporting and wholly owned subsidiaries

• This will allow it to achieve location and scale economies

as well as retain some degree of control over its worldwide

product manufacturing and distribution


GREENFIELD VENTURE OR ACQUISITION?

Should a firm establish a wholly owned subsidiary in a

country by building a subsidiary from the ground up

(greenfield strategy), or should it acquire an established

enterprise in the target market (acquisition strategy)?


Pros and Cons of Acquisition

Benefits of Acquisitions

Acquisitions have three major points in their favor:

• they are quick to execute

• acquisitions enable firms to preempt their competitors

• managers may believe acquisitions are less risky than

green-field ventures


Why Do Acquisitions Fail?

Acquisitions fail for several reasons:

• the acquiring firms often overpay for the assets of the acquired firm

• there may be a clash between the cultures of the acquiring and acquired firm

• attempts to realize synergies by integrating the operations of the acquired and acquiring entities often run into roadblocks and take much longer than forecast

• there is inadequate pre-acquisition screening


Reducing the Risks of Failure

Problems can minimized:

• through careful screening of the firm to be acquired

• by moving rapidly once the firm is acquired to implement

an integration plan


Pros and Cons of Greenfield Ventures

• The main advantage of a greenfield venture is that it gives

the firm a greater ability to build the kind of subsidiary

company that it wants

• However, greenfield ventures are slower to establish

• Greenfield ventures are also risky


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Global Business Today, 5e - · PDF fileEntering Foreign Markets ... (acquisition strategy)? Entering Foreign Markets . ... Global Business Today, 5e Author: Hill